Over the past two years, lending volumes in European real estate markets have been relatively low, largely due to a slowdown in transaction activity.
However, there are still areas where demand for debt financing has not only remained high but continues to rise.
The most important of these is green lending, i.e. lending against assets that aim to meet growing sustainability and decarbonization measures.
The commercial real estate lending market is rapidly becoming a bifurcated market. The development of green lending is happening at a speed that is captivating and only exceeded by the size of the market opportunity: demand is estimated at over €100 billion annually, according to European Commission estimates.
The reason green lending is bucking the industry-wide trend of declining lending volumes is because of the enormous scale of the underlying objective. We know that the built environment presents some of the most difficult challenges to the net zero ambitions of Western economies.
For example, the Department for Business, Energy and Industrial Strategy has made it clear that 40 percent of Britain’s energy consumption is used to supply energy to buildings, with heat generation playing a particularly important role in this.
The EU estimates that its member states alone will need 275 billion euros in capital each year by 2030 if they want to close the investment gap and achieve their planned target of reducing emissions by 55 percent.
This applies not only to commercial areas, but also to residential areas. While the question of who will finance home renovations remains hotly contested due to the dispersion of ownership in the residential sector and the financial constraints of individual homeowners, institutional real estate investors with a formal commitment to ESG goals are leading the way in meeting this demand.
Real estate accounts for a significant share of the $500 billion in green bonds and other debt issued globally each year. And that share will only continue to grow for several important reasons.
Firstly, there is still a huge backlog in the ecological renovation of existing commercial properties. This is partly due to tenants’ preferences.
JLL data shows that 83% of office tenants view climate risk as a financial risk, and a similar number expect reducing carbon emissions to be a core part of their corporate strategy.
Sponsors and developers adjust their acquisition, redevelopment and development plans accordingly.
And on the supply side, expectations about external regulation have a big impact on capital allocation decisions. Almost every investor we speak to has a growing list of ESG requirements they want to see in their portfolio holdings, and that includes their private credit investments.
Regulations such as the Sustainable Finance Disclosure Regulation, which require mandatory ESG disclosures and government targets, mean that real estate funds are more motivated to invest in greener assets. Therefore, it is in their interest to acquire more green projects. These new projects require more financing, and therefore the demand for green loans is also increasing.
Second, initial evidence suggests that assets with good sustainability credentials outperform.
In May last year, CBRE found that office buildings with sustainability certifications achieve 6% higher rents than comparable buildings without sustainability certification.
Given the prospect of higher rents, which offer more attractive price potential for equity investors, and the improved prospects for liquidity in the event of exits, it is expected that the money supply for the purchase and construction of these properties will also increase in return.
From the perspective of financial incentives for the borrower, the margin discount that he can achieve with a green loan may seem small today.
However, we expect the premium for future loans against non-ESG assets to be significant, making the effective discount much larger.
And because capital flows into green loans are growing much faster than into traditional loans, borrowers are paying attention to where supply and demand dynamics are moving in their favor.
Forward-thinking borrowers are incorporating green initiatives into their business plans. This not only enables cheaper financing, but also attracts better tenants and offers better liquidity prospects when the property is sold.
Finally, and this is quite simple, the world is only moving in one direction: towards decarbonisation. Holding an asset with a large, stagnant carbon footprint is like holding a value sink. Governments will only penalise this more severely over time, and the activity we are now seeing in green lending is partly shaped by this realisation.
In summary, there are many good reasons why the inflow of green credit capital will continue.
Tenants, buyers and investors are increasingly mindful of carbon emissions, leading to a potential shortage of products they can lease, buy or invest in. And across Europe, regulatory deadlines are fast approaching. We expect this will further drive green lending.
Headlines about the real estate industry suggest that the sector has stalled, but data suggests that green initiatives and green loans could well play an important role in reviving growth in the future.
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